11/13/2008 @ 6:00AM

Trust Me, Again

On Friday, Sept. 19, Treasury Secretary Henry Paulson marched into the Treasury Department’s media room and announced he needed several hundred billion dollars to save the financial system by buying “troubled assets.” Markets soared.

Wednesday, Paulson traipsed in again and said the $700 billion that Congress granted him will not be used to buy troubled assets after all, but rather to shore up troubled companies by taking equity stakes, among other things. “Our assessment at this time is that this is not the most effective way to use TARP funds,” Paulson said.

Paulson says he would like to use much of the remaining $350 billion to support consumer debt–the credit cards, auto loans and student loans that in regular times fuel much of the nation’s spending but have since ground to a halt. The Treasury is now exploring, along with the Federal Reserve, a possible “liquidity facility” for highly rated asset-backed securities.

Maybe it’s the right way to go, maybe not. But as the government’s efforts to shore up the nation’s economy and financial system continue to balloon, the man running those efforts is putting the most important asset he possesses right now–his credibility–at increasing risk.

By changing tactics and communicating poorly, he may be inadvertently recreating the same failed ad-hoc approach to the crisis he’s been trying to escape. That’s a problem. For the next three months, he’s still the bailer-in-chief for a market lacking confidence. Wednesday, the Dow ended the day down 411 points.

Paulson is–or was–as commanding a presence in Washington as he was on Wall Street. Ever clad in power suits and thick ties, the former Dartmouth All-Ivy football star was Goldman Sachs‘
chairman and CEO, leading the world’s premiere investment bank through its IPO (earning as much as $700 million for himself) and the heydays of the early part of the decade.

In Washington, he gained still more power and prominence as the credit crisis exploded and he became the public face of the American policy response. Paulson’s September request for $700 billion to purchase mortgage-backed securities was unprecedented. Congress questioned whether purchasing troubled assets was really the best approach. What about a plan to insure those assets? What about direct equity investments in banks? Paulson insisted troubled-asset purchase was the way to go.

The House of Representatives was unconvinced by Paulson’s testimony. On Sept. 29, they voted against the plan, and stock markets nosedived. Do not defy Paulson, seemed to be the message. The legislation was approved on Oct. 3.

The legislation was either prescient or deceptive–depending on your perspective–in granting Paulson broad authority to use the $700 billion however he saw fit. Before Congress, Paulson insisted that the legislation must be flexible to allow the Treasury to change course. But he also said the focus would be purchasing troubled mortgage-related assets.

The $700 billion would be released to Paulson piecemeal: $250 billion available immediately; the president would approve the release of the next $100 billion and Congress could pass legislation to stop the final $350 billion from release. But after receiving the first $250 billion, the Treasury department almost immediately shifted gears, a tacit admission that direct injections were faster than buying troubled assets.

“During the two weeks that Congress considered the legislation, market conditions worsened considerably,” Paulson said Wednesday. “It was clear to me by the time the bill was signed on Oct. 3 that we needed to act quickly and forcefully, and that purchasing troubled assets–our initial focus–would take time to implement and would not be sufficient given the severity of the problem.”

The entire $250 billion was instead committed to making direct equity investments in banks. The next $100 billion was released by the president, and all but $60 billion has been committed or already invested in banks and
AIG
, the insurance company that the government took over in September. The legislation had given authority for this, but Paulsons actions contradicted his early stance that the asset purchase was the best approach.

Skeptics were relieved by the change in course. “I’m glad to see that Secretary Paulson and the rest of the Treasury team has finally seen the light and decided to abandon asset purchases,” said Sen. Chuck Schumer (D-N.Y.) in a Wednesday afternoon conference call. He also said he thought Congress would allow the release of the last $350 billion, “but we might approve it with specific provisos.”

In another sign of Washington’s decaying patience, Schumer scolded the Treasury for how they used the capital injections. “They were so eager to include the nine large banks in the program initially that they made the terms much too easy.” Banks could take the injections with no requirement to lend the money back out.

In a letter to Paulson after the injections were announced, House Minority Leader John Boehner (R-Ohio) was also frustrated with the Treasury. “Reports indicate that various institutions are planning to use some funds provided under the Troubled Assets Relief Program for other purposes never discussed with me or my colleagues in Congress,” he said.

The ever-shifting piece of legislation is frustrating for Wall Street, too. Tim Ryan, president of the Securities Industry and Financial Markets Association said in a statement Wednesday that though pleased with capital injections, he was “disappointed” the troubled asset purchasing had been abandoned.

“Understandably, Treasury has both limited time and resources and must make hard choices. But as we move forward, and in planning for the next administration, we hope there will be further opportunities to comprehensively revisit this important program,” Ryan says.

In the face of the criticism, Paulson defended his actions Wednesday. “I will never apologize for changing a strategy or an approach if the facts change,” Paulson said.

Fair enough. But maybe it’s time to let everyone in on what, exactly, that strategy really is.